End of Week Notes
Trump regulators either don’t get ESG investing or see it as a threat to their worldview
With the Trump administration scrambling to get new rules in place before being run out of office in November, ESG investing is in its crosshairs.
A proposed Department of Labor (DOL) rule would try to limit retirement plans regulated under ERISA from using ESG-focused investment strategies. Meanwhile, the Securities and Exchange Commission (SEC) is trying to limit the ability of small investor/shareholders to propose resolutions, which often touch on ESG issues, to be voted on at companies’ annual general meetings, limit the ability of all shareholders to resubmit such proposals at subsequent meetings, and limit the ability of proxy advisors to give independent advice on such proposals to their asset-manager clients.
Beyond that, the SEC’s partisan majority (two Republicans — Elad Roisman and Hester Peirce — and “independent” chair Jay Clayton, currently nominated to become the learn-on-the-job U.S. attorney for the Southern District of New York that’s running several investigations touching on his golfing buddy, Trump) is considering requiring additional disclosures of ESG investment funds but is opposing investor requests to require company ESG disclosures, including one from its own SEC Investor Advisory Committee.
Based on their comments and proposals, what is clear is that Trump regulators don’t really get ESG investing, or perhaps they deliberately “misunderstand” it. They consider ESG to be political activism dressed up as investing, rather than investing that takes into account the impact of material environmental and social risks on their investments in order to enhance risk-adjusted returns.
The DOL commentary on the proposed rule allows, only in passing and without giving a single exmple, that “there could be instances where ESG issues present material business risk or opportunities” that investors should consider (p. 6), but nowhere acknowledges this to be the central feature of ESG investing and warns against fiduciaries “too readily” treating ESG factors as economically relevant (p. 7). Climate change, easily the biggest material ESG risk for many companies, especially the fossil-fuel companies that Trump administration policies like these are trying to protect, doesn’t merit a single mention in the 61-page document.
And in a speech this week the best example of a material ESG issue SEC Commissioner Elad Roisman could come up with was this:
[I]f a company decided to take a public stance on a certain social or political issue, there may be a risk that it could lose a substantial percentage of its customers who disagree with that stance, resulting in a material adverse financial effect. That may be a risk the company is willing to take, but it may also have to disclose that to investors.
That’s it?
If either Commissioner Roisman or the DOL were serious about understanding the question of ESG materiality they might have consulted the Sustainable Accounting Standards Board (SASB) Materiality Map, which identifies 26 sustainability issue areas that are likely to affect the financial condition or operating performance of companies on an industry-by-industry basis. Or they might have discussed the findings of Khan, Serafeim and Yoon (2016) that companies that address material ESG issues most effectively tend to outperform financially and as investments.
Commissioner Roisman did mention climate change once in his speech, but as an example of a political issue rather than one that may be material to an investment. In trying to explain “E” and “S” issues, Roisman said:
Those matters tend to be more society, or stakeholder, focused. For example: How is the company “doing its part” to combat climate change or address global and political matters?
The entire focus of the DOL rule is predicated on a definition of ESG investing as primarily about offering supposed “non-pecuniary” benefits to investors, that could come at the expense of returns, despite years of DOL guidance that such investments are allowed so long as they don’t come at the expense of returns. Neither does the proposal cite, much less discuss, the mountain of research suggesting, at worst, that ESG investment performance is on par with conventional investments.
The entire focus of the SEC rules is to keep investors from asking companies to disclose ESG-related risks and to keep them from voting for such resolutions, which they have been doing in record numbers in recent years, despite the fact that such questions need to show a material nexus to even be allowed on the proxy ballot.
Neither the DOL nor the SEC has come to grips with what ESG investing is about today. At the most fundamental level, it’s about basing investment decisions on a more holistic view of a company made possible by the wide availability of ESG data, rather than limiting investment analysis to traditional financial accounting factors. This helps investors understand how sustainable a firm’s long-term business model is, how it treats all its stakeholders, and provides an early warning on environmental and social risks before they affect company value.
At a time when consumers and talented workers are more often basing their purchasing and employment decisions, in part, on their view of a company’s sustainability, it is critical that investors take these matters into account. To do otherwise would be a breach of fiduciary duty.
While ESG investing is about investing first and foremost, the fact that it may also contribute to broader positive societal and environmental outcomes should be seen as a benefit not a defect, and not as a problem that needs to be regulated away.
If I thought the Trump regulators were neutral arbiters struggling with how to understand ESG, then I’d say that they are confused. Yes, ESG risks do concern issues that activists care about because they are also broader risks to society and the planet. Hence, end-investors concerned about such things are likely supporters of ESG investing, but that doesn’t mean the way asset managers use ESG insights to improve their returns is inherently political or about concessionary returns.
But they are not neutral arbiters, they are political ideologues who see this in political terms and are using concepts like fiduciary duty to try to keep investors from quite reasonably and responsibly considering material issues like climate risk in investment analyis.
This is why we have elections.
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Senator criticizes DOL proposal
Sen. Patty Murray (D-WA), ranking member of the Senate Health, Education, Labor and Pensions (HELP) Committee, says the DOL proposed rule would “discourage financial advisors from considering ESG criteria and ignores findings that show ESG investments outperform traditional investments.”
If Democrats take control of the Senate, Sen. Murray would be in line to helm this committee, which has primary jurisdiction over ERISA-related issues.
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Will Asset Managers step up to defend ESG?
Joel Makower makes the case for ESG, notes that fossil-fuel, extractive, and dirty manufacturing companies that tend not to fare well in ESG portfolios and their DC lobbyists are responsible for the Trump administration’s attacks on ESG investing, but then asks a great question:
So where are the countervailing forces — the lobbyists for the Goldmans and Vanguards and State Streets that have been aggressively pushing ESG investment products?…
Who will step into the void? Or will we once again let those best able to buy influence steamroll progress?
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DOL is holding ESG to a higher standard
My colleague John Rekanthaler says the DOL wants to hold ESG investing to a higher standard:
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ESG Funds are actually great choices for retirement accounts
From The Motley Fool’s Bram Berkowitz:
If you’re planning for retirement a ways down the road, you want to fill your portfolio with stocks that will grow your savings in the long term. ESG stocks and funds fit this requirement because issues like climate change will not be solved overnight. Not only are many of these stocks in imperative industries, but also in what are expected to be fast-growing industries. A balanced selection of more established companies dedicated to improving ESG issues and those with more direct involvement in ESG should bode well for your portfolio.
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Jay Clayton is all about “Main Street” investors
Finally, there is this on the aforementioned SEC Chair Jay Clayton, who apparently possesses such singular brilliance that he is able to shift from being SEC Chair to the federal prosecutor for the SDNY, despite having no prosecutorial experience.
In Attorney General Barr’s press release on Clayton’s SDNY nomination, Barr praised Clayton’s work to “protect Main Street investors”, thus furthering the absolute fiction that everyday investors somehow are demanding the shareholder resolution and proxy advisor regulations the SEC is considering.
Two years ago, a bona fide DC-swamp group of right-wing business trade organizations created an astroturf (fake grass-roots) group called “The Main Street Investors Coalition” to create this impression. They were roundly mocked and, more or less, disappeared from view, except that the phrase turned up in a bunch of comment letters sent to the SEC late last year.
In December, Clayton, in sworn testimony to Congress, noted supportive letters written by “Main Street” investors, but they had apparently been written by a dark money group known as “60 Plus”. When Sen. Chris Van Hollen (D-MD) called him on it, Clayton said he’d look into it.
Having heard nothing, Sen. Van Hollen wrote Clayton this week:
I would also like to know how the SEC intends to account for the fact that the changes it is seeking in the regulation of proxy advisors do not appear to be based on concerns of “Main Street” investors, as the revelations around the public comments clearly show, but instead emanate from corporate heads and boards that oppose investor oversight or review of their actions and proposals. Until the investigation of this orchestrated campaign of fraudulent comment letters is resolved, I urge that the SEC refrain from finalizing the SEC’s proposed rule on Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8.
